HOME OF "PICTURES OF A STOCK MARKET MANIA"
July 26, 2006
Alan M. Newman's Stock Market CROSSCURRENTS
Alan M. Newman, Editor
These excerpts from the July 24th issuehave been posted
to coincide with receipt by snail-mail subscribers.
Fearless Or Foolish?
Businessweek's 2005 year end survey (
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Prime Brokers In Trouble?
The Securities & Exchange Commission held an"Open Meeting" on Wednesday, July 12, 2006. In his opening statement, SECChairman Christopher Cox cited the second Item on the agenda, proposed amendments toRegulation SHO. Cox said, "The next item on our agenda is the serious problemof abusive naked short sales, which can be used as a tool to drive down a company's stockprice to the detriment of all of its investors. The Commission is particularly concernedabout persistent failures to deliver in the market for some securities that may be due toloopholes in the Commission's Regulation SHO, adopted just two years ago." So,it appears our analysis has been dead on correct all along. The Thresholdlists clearly show the grandfathering of fails has allowed naked short positions to remainundelivered since Regulation SHO first went into effect on January 5, 2005.
On several occasions, we wrote about two companiesthat appear regularly on the "Threshold list," indicating fails above a levelthe SEC initially deemed intolerable. We wrote with strong conviction that each ofthese companies, along with others, were "targeted for destruction." Wealso wrote about other negative effects of naked shorting, including the loss of votingrights for investors and taxable income paid in lieu of qualified dividends that wouldotherwise be treated preferentially for tax purposes. We were and are still 100%correct in our analysis. In his statement, Chairman Cox confirmed our criticisms,stating "We are particularly concerned about the potential negative effect thatsubstantial and persistent fails to deliver may be having on the market in somesecurities. Specifically, these fails to deliver can deprive shareholders of the benefitsof ownership - voting, lending, and dividends from issuers. Moreover, they can beindicative of abusive naked short selling, which could be used as a tool to drive down acompany's stock price. They may also undermine the confidence of investors who may believethat the fails to deliver are evidence of manipulative naked short selling in the stock.In turn, issuers may be harmed, as investors may be reluctant to commit capital to a stockthat they believe is subject to abusive naked short selling."
And if this was not sufficient to finally turn someheads, we also have former SEC Chairman Harvey Pitt's article in Forbes online (
The two stocks we have cited most often as"targeted for destruction" remain heavily shorted. Incredibly, NovaStarFinancial (NFI) sports an annual dividend of $5.60, a 17.4% yield, and in addition, willlikely pay out a Special Dividend of $3 in the fall. Short sellers are liable forthe dividends. Thus, even if NFI simply trades sideways, shorts lose money. The company's shares fell dramatically in April 2004, when hit by a two-pronged attack bya negative Wall Street Journal article followed immediately by a succession of classaction suits. Amazingly, none of the concerns voiced in the article have materiallyimpacted the company's business and the initial class action lawsuit brought within 48hours of the WSJ article, was filed by a firm that has now been indicted for criminalpractices regarding their class action zeal. But nearly one-third of NovaStar'sshares remain short and the stock trades at virtually the same price as in April2004. In the interim, NFI (and the shorts) have paid out $13.25 in dividends. However, with such a huge position in place, those short have no hope of covering withoutengineering their own demise in a short squeeze of epic proportions. Thus, theirbest bet appears to continue to short the shares, naked or not, in order to keep heavypressure on the share price in the hope that eventually, something goes wrong atNovaStar. As a result, short interest has risen 35% since soon after the big plungein April 2004.
Nearly two of every five shares of Overstock.comremain shorted, while the company's CEO and business continue to be vilified by the mediaand certain interested parties. Meanwhile, after factoring in insider holdings (
The sudden concerns voiced by the current and pastSEC Chairpersons clearly signal that the financial industry will have to take a few giantsteps to resolve the issues of fairness to investors and transparency of ourmarkets. The lawsuit recently brought by a group of NFI shareholders against severalof the largest brokerage firms for assisting in the naked shorting of NFI shares shouldact as a pointed reminder that the industry faces enormous liabilities in thismatter. As well, two law suits have been filed by hedge funds against the largest“prime” brokers for conspiring to charge exorbitant fees for borrowing stock tolend to shorts, and not actually borrowing or delivering said stock. We expect thegiant steps will ultimately reveal liabilities measured in many billions of dollars.
Our April 24th call was “...from here on, itmay all be downhill for the brokers,” catching the exact top in the XBD Broker-DealerIndex. Next was our May 22nd call to “Avoid Banks, Avoid Brokers.” The initial decline of 22% in less than two months was followed by a corrective rally thatmay have now ended. We continue to look for much lower prices for the broker dealerissues. Eventually, we believe even the summer lows of 2004 for the XBD couldpossibly be threatened, more than 40% below today. While any of the supports shownabove could hold, we harbor no optimism for the sector. The time has come. Thepiper must be paid.
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ABOUT ALAN M. NEWMAN
Alan M. Newman has been the Editor of CROSSCURRENTSsince the first issue was published in May of 1990. Mr. Newman is also a member of theMarket Technician's Association and has been widely quoted foryears by the financial press, media, and other newsletters and has written articles forBARRON'S.
The newsletter is published roughly every threeweeks and focuses on economic and stock market commentary, often covering controversialsubjects. Several proprietary technical indicators are usually featured in every issueaccompanied by current interpretation. Broad samples of our work can be viewed athttp://www.cross-currents.net/.
Subscription rates are now $189 for one year and$100 for six months. A FREE 3 issue trial subscription is available by emailing us(click the "free trial" link above). Please note:trial requests must include name, address and phone number and mustoriginate from the email address the trial is to be delivered. Trials areonly available by Email (.pdf files). U.S. Mail subscriptions are availablebut include a nominal surcharge for postage and handling.
